WTAI: Thematic AI Fund From WisdomTree (BATS:WTAI)

Thesis

Artificial Intelligence (or AI in short), is the topic ‘du jour’ in the equity space. We are witnessing a race for CEOs to mention AI on their conference calls, expecting positive market reaction to the theme. As an end user, I have utilized ChatGPT from OpenAI and Bard from Google (GOOGL). They are indeed helpful, innovative tools, and I can certainly see how their application will grow and insert itself into more and more sectors. Furthermore, I have a friend who is an entrepreneur who owns and develops a fashion app for mobile phones. In essence the app allows users to create ‘outfits’ and then learn based on preferences and makes suggestions. His app has a ChatGPT API, which he told me is essential to run his application.

All the ingredients are there for this technology to embed itself in more aspects of our life, yet the question is what is the correct valuation. In this article we are going to explore a new offering from WisdomTree, which is geared towards this nascent sector.

WisdomTree Artificial Intelligence and Innovation Fund ETF (BATS:WTAI) is a new exchange traded fund. The vehicle was IPO-ed in 2021 and, as per its literature:

[…] seeks to track the price and yield performance, before fees and expenses, of the WisdomTree Artificial Intelligence & Innovation Index, which identifies companies that are primarily involved in the investment theme of AI and Innovation.

This is a rules based index, and one can find the full methodology and mechanics here. I will go into more detail regarding the index in the below subsection, but what I like about its composition, and the resulting ETF composition, is its balanced approach to the various components of the AI ecosystem: AI software, semiconductors, other hardware and innovation.

WisdomTree AI & Innovation Index

The index takes a unique approach in building up its holdings:

The Index selection process focuses on the specific functionality that each constituent is contributing to the development and deployment of AI, in an effort to provide precise access to this megatrend. The WisdomTree Artificial Intelligence & Innovation Index (WAII) seeks to identify companies that are involved in targeted AI subthemes within each of the following categories: Software, Semiconductors, AI Other Hardware, Innovation. The constituents identified are then ranked and weighted to determine the final allocation within the Index, and it is rebalanced semi-annually.

This approach results in an ETF that has 75 individual issuers, and a granular build:

None of the fund holdings are more than 3% of the portfolio, ensuring a sectoral cross-section rather than individual name concentration. When we go back to the index build, we can see how each individual name falls in the overarching fund theme:

Performance

The fund has a year to date performance fairly in line with the Nasdaq:

The semiconductor focused (SOXX) is the clear winner in the cohort, followed by the Global X Robotics & Artificial Intelligence Thematic ETF (BOTZ), which has a high concentration in NVIDIA (NVDA). I do not like BOTZ for the composition, because its top names are around 8% of the portfolio each (its top 10 names account for over 60% of the fund). Long term, more granular funds will outperform in my opinion.

Since January 2022, the fund lags the wider Nasdaq index:

Valuations

We have established the theme is a good one and AI has very practical applications which will expand with time. But the correct question to ask at this stage is around valuations, and whether they are overstretched. Let us have a look at some of the fund’s key valuation metrics:

We can see the WisdomTree Artificial Intelligence & Innovation Index (WAII) index figures in the first column in the table, and they look stretched: a blown out P/E ratio versus the S&P 500 Info Tech, a forward P/E which is also wide, but a P/S ratio below the Info Tech one. The sales growth in the past year for the underlying companies is indeed at 38%, much above what we see in the S&P 500 Info Tech space, but a conversion from sales to actual net income can take time or not happen at all. High Fed Fund rates of 5% do not help with the valuation case either.

Conclusion

WisdomTree Artificial Intelligence and Innovation Fund ETF is a new thematic fund that tries to exploit the AI market theme. The fund aims to replicate the WisdomTree Artificial Intelligence & Innovation Index, and uses four fundamental pillars for its construction, namely the following sub-sectors: Software, Semiconductors, AI Other Hardware and Innovation. The fund has a granular build, with all names under 3% of the total portfolio. The vehicle is an interesting proposal and has the right ingredients to embed the returns of the chosen theme in the coming years. I feel the current valuation for the sector is overstretched, with P/E and P/S metrics reminding me of the go-go days of 2020 and zero rates. WTAI is a compelling portfolio allocation for the growth bucket, but a retail investor should wait for a 20% correction to enter this name.